The original intent of conventional banking was to serve as pure intermediary between surplus fund holders and deficit units in the economy. In this role banks transferred risk from depositors to borrowers. An edifice of deposit insurance system and supervisory/regulatory structure was erected to protect the creditor at the expense of the debtor. In the last five decades, however, advances in information technology and in financial innovations have made possible the emergence of an immense capacity for rapid regime switching from risk transfer by risk shifting was amply pronounced in the financial crisis of 2007/2008. The fallout from the crisis has intensified calls for a re-examination of current banking model. Banks' tendency to shift the risk of losses to external parties, while internalizing gains through debt-based contracts (Sheng, 2009), creates a minority class (equity holders and financiers) that benefits from economic and financial growth and excludes a majority (depositors and tax payers) from sharing in the prosperity. Worse still, the majority stands to bear the brunt of recurrent risk-shifting induced crises.
Alaa Alaabed; Abul Mansur Mohammed Masih; Abbas Mirakhor (2015)
Automatically, risk shifting is absent in an ideal Islamic financial system (The Kuala Lumpur Declaration, 2012). Creating an opportunity for shared prosperity is a litmus test of the authenticity of Islamic banking. The present formation of Islamic finance has grown out of conventional finance and it uses its instruments.
